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BOND MATH: The Theory Behind the Formulas by Donald J. Smith

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Bond Portfolio Statistics in Theory

We can think of a portfolio of fixed-income bonds as just one big bond representing many promised payments on scheduled future dates. In doing this we focus on cash flow, not on how the payments are accounted for as interest income or redemption of principal. This big-bundle-of-cash-flow approach makes sense only if the bonds are fairly homogeneous with respect to credit risk and taxation. It would be hard to interpret the summary statistics on a bond portfolio made up of half low-yield, high-quality, federal tax-exempt municipals and half high-yield, non–investment-grade corporate bonds.

Suppose that our portfolio is comprised of a homogeneous class of traditional fixed-income securities, for instance, semiannual ...

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